Monday, March 30, 2009

DISTURBING DEVELOPMENTS (GEITNER PLAN)

Is there anything in this auction plan that prohibits the sellers to finance the buyers? After all, the sellers are big banks and that's what they are designed to do: finance profitable enterprise.

What if a bank A enters a contract with a financial entity B, such that for every dollar that B spends at the auction, A offers it a free dollar in credit with loose return requirement. Then B carries practically zero risk and is interested in gobbling as much of the toxic asset as possible, driving the auction price way beyond the fair value (whatever that is). For every extra dollar that is spent at the auction, bank A collects 12 dollars from the government, so the dollar it gave away (to B) is not a factor. Both sides are pulling an arbitrage of a lifetime, at the expense of the taxpayer. The price could easily go even above 100 cents on a dollar. Of course, this would attract unwanted scrutiny and public outrage, so the parties (banks and government) instead would just agree on mutually acceptable prices. To make it a “success”, Geithner would have to agree on banks' asking price, just like the initial TARP plan: direct subsidy to the banks, only under the cover of the “auction-fair-value” fig leaf and with fewer strings attached, it seems.

So what would preclude such a scenario? Even if banks are prohibited to finance the buyers directly, isn't there always a way to create the same contract through multiple intermediaries and complex derivative instruments? Too difficult? As long as it's legal, with hundreds of billions of free dollars on the table, the smart people of Wall St. will surely not miss the chance.